When Should Clients Start Claiming Social Security Benefits?

Claim right away or wait? Your advice to clients can make all the difference. Heres what to consider.

By William H. Byrnes, Robert Bloink|April 27, 2012 at 07:12 AM

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It is tempting for your clients to jump at the opportunity to claim Social Security benefits as soon as they become eligible, but for many clients, this might not be the wisest move. Whether a client waits until age 70 or begins taking benefits at 62, taxation of Social Security benefits is complicated and interacts with taxes on retirement accounts and other income in ways that are not easy to anticipate. Your advice in this area can make all the difference in minimizing taxes on Social Security benefits and ensuring that your clients receive the maximum from Social Security to supplement their retirement income.

When to Start Collecting

Your clients can elect to begin collecting Social Security benefits anytime between ages 62 and 70, but as you know, the size of the monthly benefit increases when payments begin later. For example, a retiree earning about $150,000 a year could collect about $1,760 per month if he chooses to begin receiving benefits at age 62, but the amount increases to $2,388 beginning at age 66 and $3,209 per month at age 70.

While this system is designed to approximate equal benefits for all recipients, in reality the situation is different for each client. A client with a higher life expectancy might be well advised to delay collecting payments until age 70, but this depends on his retirement portfolio and general financial situation.

Usually, your clients should not begin collecting Social Security until they have retired, especially if they are younger than age 66 (which is considered full retirement age). Before age 66, tax penalties are applied to any earnings above $14,640, so that for every additional $2 earned, $1 can be lost to taxes.

If your client is retired and has other retirement funds to draw upon, there are reasons why it might be beneficial to wait until his full retirement age (or even later) to begin collecting benefits. For example, a married decedent’s surviving spouse is entitled to choose between the higher of the two benefit checks (assuming both were receiving benefits). If the spouse who provides the couple’s primary source of income waits until age 70 to claim benefits, a lower income spouse can later claim this higher benefit.

Regardless of when your client chooses to begin collecting Social Security, she needs to understand how benefits will be taxed. Not all Social Security benefits are subject to income taxes—the percentage of benefits subject to tax is based on the recipient’s combined income. Combined income means adjusted gross income (AGI) plus tax-exempt income and one-half of Social Security benefits.

For a married couple with combined income of between $32,000 and 44,000 ($25,000 to $34,000 for an individual), 50% of Social Security benefits will be taxed. This percentage jumps to 85% for couples with combined income over $44,000 ($34,000 for an individual).

Clients who are still earning while collecting Social Security obviously subject their benefits to a higher level of tax than those who have already retired, but income from retirement accounts is also considered.

For example, if your client is an individual with AGI plus Social Security benefits that exceeds $34,000, she must carefully consider how additional income will be taxed. If an additional $1,000 is withdrawn from a 401(k), taxable income will actually be increased by $1,850 because an additional $850 (85% of $1,000) of Social Security benefits will become subject to tax. If the client were to withdraw funds from a Roth IRA, where taxes are paid when deposited and not when withdrawn, she could avoid the extra taxes on Social Security income.

Wrapping Up

While there are no simple answers to clients’ questions about Social Security, sound financial advice can be critical in the decision-making process. Managing the way Social Security and withdrawals from retirement accounts are timed can help your clients save substantially and maximize the benefits they are entitled to receive throughout retirement.

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